Higher Interest Rates Won't Halt Bullish Stampede, Adviser Concludes

June 12, 1986|By Dan Dorfman

NEW YORK — The recent spurt in interest rates has sparked a hefty dash of profit- taking -- both among the public and the pros.

Well, if you're one of the worriers, don't panic. The reason: Contrary to what a lot of investors think, rising interest rates, but not soaring rates, are not indicative of lower stock prices ahead, I'm told. In fact, the stock market is likely to move sharply higher after interest rates have hit bottom and have begun moving up.

This surprising revelation is solidly documented in an intriguing analysis by Argus Research Corp., a leading investment adviser.

In brief, says James Solloway, an Argus director, a bull market has two parts. The first is fueled by anticipation of lower interest rates; the second is sparked by rising profits.

Solloway makes a convincing argument. In the past nine post-World War II bull markets, excluding the current one, stock prices, as measured by Standard & Poor's 500-stock index, moved higher every single time -- not only after rates had bottomed, but even during the period in which they moved up.

And the gains were substantially greater during the period of rising rates. Let's look at the numbers. From the start of those nine bull markets until interest rates hit their lows, stock prices rose an average 17.1 percent. But in the subsequent period of rising interest rates to the end of the bull market, stock prices shot up on average an additional 34.9 percent. So, in effect, investors shrugged off the fears of rising rates.

Why is the market able to advance in a period of rising rates?

The answer: rising corporate profits. At some point the direction of interest rates, barring a sharp, sustained rise, becomes less relevant in an ongoing bull market, Solloway observes.

The course of interest rates is by no means unimportant, says Solloway. On the contrary, it matters a lot since bull markets usually get going in a period of declining rates. But at some point, he adds, the emphasis shifts -- with profits, not interest rates, powering the market. And that's the case now, he tells me: ''We've moved from an interest-rate-driven market to a profits-driven market.''

Accordingly, Argus suggests building stock positions in industries that will benefit from a livelier economy, namely chemicals, paper, retailers and home-improvement centers.

Argus also analyzed corporate profits during the nine bull markets (excluding the current one). And it came up with a significant finding -- namely, in five of those bull markets the gain in stock prices ran pretty close to the gain in corporate profits from the time interest rates hit their bottom to the end of the bull market.

The economic scenario by Argus calls for a 10 percent gain in 1986 profits and a 15 percent rise in 1987 earnings.

What about interest rates?

Our bull thinks they've probably seen their bottom, but he's not looking for any kind of surge -- given low inflation and an overall significant easing of inflationary expectations.

Solloway figures long-term interest rates, about 7.8 percent now, should wind up the year at about 8 percent. And at the end of 1987, he sees a further modest rise to a bit above 8.5 percent.

''We're probably more than half way through the bull market,'' says Solloway, ''but everything we see tells us it's still too soon to get out.''